Essays on the Capital Structure Decisions

Abstract

This thesis consists of two essays on the capital structure decisions. Two essays revisit prior literature on the capital structure decisions by addressing their shortcomings. Although two essays investigate different determinants of capital structure decisions (i.e., financial reporting quality for 1st essay and competition type for 2nd essay), they contribute to the literature by showing that addressing shortcomings in prior literature can yield different implications. First essay tests the effect of reporting quality on financing choices between debt and equity financing. Extant research suggests that firms with high quality financial reporting benefit from low costs of raising debt or equity. However, little is yet known about which benefit in debt or equity financing is greater and whether the ex ante differential in benefits turn to ex post differential in financing. This paper tests how financial reporting quality influences the interdependence of cash holding, debt financing, and equity financing to fund the financing deficit (i.e., negative free cash flow). It finds that in order to fund one dollar for financing needs, firms in the highest decile of reporting quality use $0.27 of cash holding and issue $0.61 of debt and $0.12 of equity, whereas firms in the lowest decile use $0.29 of cash reserves and issue $0.44 of debt and $0.27 of equity. This indicates that firms with higher reporting quality rely more on debt financing than on equity financing. This paper further documents that the differential impact of reporting quality in debt financing and equity financing is more salient in firms with private long-term debts and in financially constrained firms, supporting the debt contracting value of accounting information. Second essay highlights the difference between price and non-price competition and expands prior studies on the relations that product market competition intensity has with capital structure and payout policies. Specifically, non-price competition intensity is positively related with the use of equity financing relative to debt financing. Also, firms accumulate more cash reserves by reducing the distribution of free cash flows to outside investors as non-price competition intensifies. However, such relations are weaker for price competition industries. These findings suggest that the competition type can be an important explanatory factor on the relations between competition intensity and financial policies.